The effects of an uncertain abandonment value on the investment decision

Using a three-factor stochastic real option model framework, this paper examines the effects of abandonment on the investment decision. Abandonment is classified according to whether the opportunity arises for an active operating asset post-investment, or for holding the project opportunity pre-inve...

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Bibliographic Details
Published in:The European journal of finance 2017-09, Vol.23 (12), p.1083-1106
Main Authors: Adkins, Roger, Paxson, Dean
Format: Article
Language:English
Subjects:
abandonment value
Economic models
Investment decision
Investments
post/pre investment
real option analysis
Real options analysis
Sensitivity analysis
Stochastic models
Value
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Summary:Using a three-factor stochastic real option model framework, this paper examines the effects of abandonment on the investment decision. Abandonment is classified according to whether the opportunity arises for an active operating asset post-investment, or for holding the project opportunity pre-investment. Separate analytical models are developed for the alternative forms of abandonment optionality. Numerical sensitivity analysis shows that the presence of a post-investment abandonment opportunity makes the investment opportunity appear to be more attractive because of the abandonment option value, but not by a considerable amount. Also, in contrast to the standard real option finding, an abandonment value volatility increase produces a project value threshold fall owing to the increase in the abandonment option value.
ISSN:1351-847X
1466-4364
DOI:10.1080/1351847X.2015.1113195